International Series

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Unit 2 — The Firm

Purpose:

To explain the concept of the production function, and to describe how firms can minimize their costs of production by utilizing an optimal combination of inputs and scale of operation.

Objectives:

The relationship between the rate of output of a commodity and the rate at which inputs are used is called the production function.

An “input” is a factor, such as labor, machinery, or land, that contributes to production.

A production function “embodies” a given technology; a change in technology changes the relationship between inputs and output.

If a percentage increase in all inputs results in an increase in output greater than the percentage increase in inputs, the production process has economies of scale.

Some inputs can be changed more easily than others in response to a change in demand. Those inputs (such as labor, raw materials, or energy) are called variable inputs, and inputs which can only change in the long run (such as a factory) are called fixed inputs.

If the successive additions to output lessen as more and more of an input is added (while technology and the quantity of other inputs are held constant), the input is subject to diminishing marginal returns.

To minimize its costs, a firm must choose a combination of inputs to meet the following condition: the marginal product of a dollar’s worth of any one input must equal the marginal product of a dollar’s worth of any other input used.

Studebaker Automobiles manufactured three styles of passenger cars and two models of trucks. During a given month in the life of Studebaker, which of the following would MOST LIKELY be classified as a fixed input?

labor

paint

tooling equipment

the two models of trucks

This would be the input most difficult to change over a short period of time. The last option is a product, not an input.